What Is Goldman Sachs?

One of the most striking things about Goldman Sachs earnings reports is that the firm pretends it doesn't trade at all. Yet it derives about half of its income from things that many people would consider trading.

For years now, Goldman has banished the word
tradingfrom its lexicon. You won't find the word in its earnings reports. Officially, the firm just doesn't having trading units at all. Instead they have "market markers" who are supposedly focused on facilitating customer business. And other folks who make "principal transactions," which means making longer term investments with Goldman's money.

The phrases market making and customer facilitation, however, conceal the fact that these things involve a lot of trading. And not just trading in response to customer orders. You see, Goldmandoesn't wait for a customer to place an order for a financial product before it takes a position in a product. It facilitates customers by anticipating customer order flow. That is to say, it buys and sells financial assets that it expects its clients will want to buy or sell in the future.

This kind of anticipatory trading is not fairly described as front-running because Goldman isn't stepping ahead of customers who have already requested positions. It's stepping ahead of them before they request these positions.

It is an intensely lucrative business for Goldman. And one that is bringing in increasingly large sums of money for the firm.

In the fourth quarter of 2012, Goldman made nearly $2.7 billion in its market making unit. That's a 109 percent rise from the fourth quarter of 2011. Even if you back out the $500 million Goldman made from the sale of its hedge fund administration business, Goldman improved its trading—sorry, market making—performance by 70 percent over the fourth quarter of the prior year.

Revenues from "other principal transactions" grew 135 percent from a year earlier, to $1.9 billion. These are investments that the firm makes with its own money. This isn't considered trading because Goldman intends to keep the positions open for longer periods of time—although it doesn't always end up doing this.

Goldman's overall revenue for the fourth quarter came in at $9.2 billion. This means that market making and principal transactions combine for about half of Goldman's fourth quarter earnings.

This isn't a one-quarter fluke. Goldman revenue for the entire year was just over $34.1 billion. The market making and principal transactions took in $17.2 billion. Just about 50 percent, again.

Goldman might not be able to bring itself to use the word trading. But that doesn't stop it from making money doing the unmentionable.